What is an Escrow?
An Escrow is a legal concept describing a financial arrangement for a third party to hold the assets of a transaction temporarily. Escrow refers to a financial agreement where a neutral third party holds assets or funds before they are transferred from one party in a transaction to another.
The main purpose of an escrow is to ensure that everybody sticks to their end of the bargain. It is used when the buyer or seller (or both) needs extra reassurance that both parties will live up to their obligations under the transaction’s contract. The third party holds the funds until both the buyer and the seller have fulfilled their contractual requirements.
What is an Escrow Account?
An escrow account in India is a bank account with conditions on ownership of funds. An escrow account is an account where funds are held in trust whilst two or more parties complete a transaction. An escrow account is set up by an escrow agency in which both the seller and buyer (or their solicitors) are joint account holders.
An escrow agent is a mediator who holds this escrow account. Escrow accounts are often used for real estate, digital lending, e-commerce, digital marketplaces, online gaming and more. An escrow agency will collect fees from both parties, which are usually expressed as a percentage of the transaction’s value. Escrow accounts significantly reduce the risk of non-payment or counterparty risks.
Benefits of an Escrow Account:
- Escrow agent acts as a neutral third party to mediate any disputes
- Transactions are more streamlined by automating the payment and compliance process
- Features like multi-bank routing, auto reconciliation, trusteeship services and APIs
- Improved trust between parties involved in the transaction
What is an Escrow Agreement?
An escrow agreement is a contract between 3 parties: a buyer, a seller and the escrow agent. The agreement lists the terms and conditions of the escrow payment.
A depositor deposits funds or assets with the escrow agent in this agreement. Once the terms in the escrow agreement are met, the escrow agent releases the money or assets to the beneficiary.
Format of Escrow Agreement:
An escrow agreement generally contains the following details:
- Names and addresses of the buyer, seller, and escrow agent
- Description of the property or assets being held in escrow
- Amount of money or value of the assets being held in escrow
- Conditions that must be met before the money or assets are released
- Fees that will be charged by the escrow agent
- Procedures for resolving disputes
- The time period for completing the escrow payment
- Method for notifying the escrow agent of any problems
- Procedures for releasing the money or assets if the transaction is not completed
- Procedures for resolving disputes if there is a disagreement about whether the conditions of the agreement have been met
The agreement may be terminated if one or both parties do not meet these terms.
Examples of Escrow:
Escrow accounts are used in a variety of transactions across industries. Listed below are the major uses.
- Escrow in Real Estate:
Escrow accounts can apply to real estate transactions. Real estate transactions involve huge amounts of money and are high risk for both buyer and seller since there is the possibility that either party might not meet their obligations. Escrow accounts help mitigate this risk. The escrow agent takes possession of the property and holds the buyer’s money till all terms and conditions are met. Once met, the agent releases the property to the buyer and the money to the seller.
- Escrow and the Stock Market:
Stocks are often issued in escrow. When stocks are issued to employees as a bonus, they must usually wait for an escrow period to pass before they have the option to sell their stocks.
In India, when a company issues shares to the public, the issuance is only valid if more than 90% of the shares are subscribed to. If less than 90% of the shares issued are subscribed to, the money is returned back to the investors. To ensure this happens, the company issuing shares is required to open an escrow account and receive subscription money to that account.
- Escrow in Online Sales:
Customer trust in e-commerce and digital marketplaces is very important. Most customers are wary of trusting online sellers because there is the risk of receiving defective products, or even not receiving the product at all.
To address these risks, most e-commerce sellers choose to receive money through an escrow account, which will only release money to the seller upon delivery and verification of the product.
- Escrow in Online Gaming:
Online gaming platforms like Dream11 and MPL allow players to play games online and win real money. Players must pay an entry fee to enter a game, out of which the prize money is paid to the winner. Till the winner is determined, the pool money is held in an escrow account to eliminate the risk of fraud.
Advantages and Disadvantages of Escrow:
Advantages of Escrow:
- Provides protection for both the buyer and the seller, ensuring that a satisfactory result is attained for both parties and potentially improving the likelihood of future transactions
- Allows high-value commodities to be traded safely and mitigates risk
- Can potentially allow for taxes and insurance to be paid monthly rather than as a lump sum
Disadvantages of Escrow:
- Escrow fees can impact on profits. For online sales, escrow fees may be more expensive than using an intermediary like PayPal
- Using escrow for taxes and insurance can result in higher mortgage payments
- There’s a risk of overpaying or underpaying into an escrow account
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Note: This Post was last updated on December 2, 2024
Disclaimer: The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation i.e. December 2, 2024. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, We assume no responsibility therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not a professional advice and is subject to change without notice. We assume no responsibility for the consequences of use of such information. IN NO EVENT SHALL WE SHALL BE LIABLE FOR ANY DIRECT, INDIRECT, SPECIAL OR INCIDENTAL DAMAGE RESULTING FROM, ARISING OUT OF OR IN CONNECTION WITH THE USE OF THE INFORMATION.
